An alternative to Euro currency exit for Ireland (South)

The Irish Times – Friday, May 7, 2010

Printing money could get euro zone out of fiscal hole

OPINION: Having indebted countries borrow to lend to other indebted ones won’t save the European Monetary System from collapse but creating money to give to all the euro zone countries might, writes RICHARD DOUTHWAITE

THE GREEK bailout will not help the Greeks. Indeed, the budgetary cuts it envisages have already made matters worse. The main reason Standard and Poor’s rating agency gave last month when it downgraded that country’s bonds to junk status was that it feared the austerity package would reduce Greece’s ability to generate an income and thus pay off its debts.

According to the IMF, Greece’s public and private overseas debt amounts to
171 per cent of its national income. Once the €110 billion being lent by the IMF and other euro zone countries over the next three years has been drawn down, this debt-to-GDP ratio will be at least 223 per cent. It could be much higher in view of the drastic cuts.

A 223 per cent ratio means that even if Greece only has to pay the 5 per cent rate set for the money being made available under the rescue plan on all its debt, its overseas interest payments in 2013 would swallow up more than 10 per cent of its national income and 150 per cent of its current export income. When you realise that the country is already running a balance of payments deficit equal to about 10 per cent of its national income, such huge payments are clearly impossible.

So if the Greek rescue package cannot rescue the Greeks, who will it help?
The answer is the European banks who ignored the country’s limited overseas earning capacity and lent it €143 billion.

Almost half of this, €59 billion, came from banks in France and €34 billion from their German counterparts. A Greek default would inevitably mean expensive bank bailouts for both countries’ taxpayers.

Another reason for the “bailout” is that, if Greece is left to collapse, the other over-indebted euro zone economies, Portugal, Ireland and Spain, would almost certainly collapse too. This would mean such a massive mark-down on the €1,600 billion the four countries owe to EU banks that the entire European banking system would implode.

Germany is exposed for about a quarter of this huge amount, France for 18 per cent and Britain 17 per cent, according to the Bank for International Settlements.

Essentially, then, the bailout is an attempt to buy time in which to rescue the EU itself. The Greeks are just a facet of a massive EU-wide over-indebtedness problem. Accordingly, ad hoc rescue efforts which involve euro zone members borrowing funds to lend to a fellow-member when the bond market has it in its sights are bound to fail.

A systemic approach which cuts the entire euro zone’s debt-to-GDP levels is required.

Economic growth cannot increase incomes reliably and quickly enough to deliver the desired result. The only possible remedy is inflation. This could be engineered by having the European Central Bank create money out of nothing to give to all the euro zone countries to spend.

Each government’s allocation would be based on its population. So, rather than some states having to make spending cuts, thus cutting their national incomes while increasing their national debt, it would be the other way around.

State spending and incomes would be increased while state debts were paid down. Private debts need to be paid down too so euro zone governments would give each individual, indebted or not, an equal share of some of the ECB money. Firms would not qualify. Recipients would be required to pay off as much of their debt as the payment allowed. We could do what we liked with anything left over. This tool should be used cautiously, reducing debts slowly over two or three years. As public and private loans were repaid, the institutions which had lent the money originally would want to lend it again. Ideally, they would do so to finance a rapid transition to renewable energy.

Inevitably, however, some of the new euro would be exchanged for foreign currencies. This would push the value of the euro down, restoring the competitiveness the zone has lost since a euro was worth less than a dollar. The zone’s exports would boom and imports would fall as they would become more expensive. The increased exports and lower imports would boost the zone’s manufacturers’ order books. Employment would rise. For some months, the effect on wages and prices would be limited as there’s a lot of unemployment and spare industrial capacity in most euro zone countries.

However, the extra demand would eventually cause a significant inflation.
This would be good as, by raising wages, the inflation would make it easier for people to service their remaining debts.

Moreover, the normal objection to inflation would not apply because savers would have already been compensated for its effects by the money they had been given.

Businesses would also be helped because the inflation would lower their debt burden in real terms. In Ireland, banks would find that they had more deposits, fewer bad debts and needed less State support. The Government would have additional tax revenue, reduced social welfare costs and a lower interest bill because of its lower debt.

All in all, a very positive scenario but one which probably won’t happen because of a groundless fear that the inflation, once started, could not be controlled. Another irrational obstacle is the feeling that money cannot be created out of nothing and that, in any case, it would be somehow improper to create it only to give it away.

The proposal certainly takes us into terra incognita. However, as having heavily-indebted countries borrowing to be able to lend to other indebted ones makes no sense at all, can anyone think of a fairer, better way to stop the euro zone’s collapse?

Richard Douthwaite is an economist and the author of The Ecology of Money